Banking & Finance

Pandora’s bank

Underground lending is growing fast. Should it be legalised?

The money is real enough

The London Interbank Offered Rate recently fell below 1%, but if you are a cash-strapped entrepreneur in China you could find your own borrowing rate is more like 180% per annum.

Of course, that is not an official rate. Indeed, in the absence of collateral, you are unlikely to be given a loan by a state bank at all. No, this is the rate you will be offered for an uncollateralised loan by China’s shadowy underground banking system.

The Economic Observer cites the case of Shenzhen businessman, Li Tong who runs a furniture factory with annual sales of more than Rmb200 million ($29.2 million). He wanted to buy a piece of land next to his factory but lacked collateral. He had Rmb40 million of cash, but needed an extra Rmb20 million to close the deal. Working through a broker, he raised funds from illegal lenders at an annualised rate of 60% per annum.

The newspaper reports that, depending on the borrower’s cashflow and credit situation, monthly rates in Shenzhen average 5%, but can go as high as 15%. It quoted one underground lender as stating he was financing six enterprises a month and lending Rmb100 million every 30 days. The same source recalled: “Recently I arranged Rmb25 million of short-term lending for a business: the rate was 6% for 15 days.”

Those most in need of funds tend to be small and medium-sized manufacturers who have seen their cashflows disrupted – thanks to clients insisting on longer payment terms. The problem is particularly acute in Shenzhen, where many of China’s exporters are based.

While no exact data exists, the Economic Observer estimates that underground loans in Shenzhen reached Rmb47 billion in 2008; and based on the figures quoted by underground lenders it interviewed, it thinks around Rmb10 billion is currently being lent each month.

But underground lenders are not confined to Shenzhen. Far from it: they are a nationwide phenomenon. Earlier this year the police raided an underground bank in Jiangsu’s Yangzhou which was engaging in cross-border money laundering. The Modern Express reported that it employed 4,000 people in 22 provinces, and held funds of Rmb8.5 billion.

So just how big is the underground banking sector? The central bank commissioned a national survey, and according to its deputy director of research, Liu Ping: “The exact figure is confidential, but it is not as terrifying as we imagined.”

Some analysts estimate it could be around Rmb2 trillion, with data indicating that as many as 70% of rural households have participated in the sector in some way.

Now the government is pondering whether to ‘legalise’ the underground banks. A Lender Ordinance – prepared by the central bank – has been submitted to the government. If approved, it would allow the underground lenders to become ‘legit’ provided their bosses and executives do not have criminal records. Other provisions prohibit deposit-taking, as well as requiring that loan rates be capped at four times the country’s benchmark interest rate.

Wu Lihua of the China Finance Research Institute says the government is in a dilemma, viewing legalisation as akin to “Pandora’s box”. But in the long run Wu thinks the move is essential to build a “diversified, multi-level and competitive financial system” and break the near monopoly of the large state banks.


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